Taper

The trial balloon being floated over the market is tapering. When the latest Fed balance sheet move was announced we determined it was type of insurance policy. Insurance moves in the Funds rate were common signals in the interest rate target regime era. They also tend to be over reaching. The "1% for an extended period" and the last hike in June 2006 that inverted the curve are just two examples.

The latest adjustment did, belatedly, relieve the expiration date stress associated with prior activities. The Fed moved to data triggers to avoid messy explanations of further QE and increased efficacy debates as actions terminated. Now a new concept, led by Bullard and Yellen and outlined by Steve Liesman, of micro-managing QE is taking shape. The Fed is considering tapering LSAP levels down as/if the data moves toward the target(s). (There is an inflation target with near equal weight to the more heavily followed Unemployment target) Bullard suggested the tapering could use a guideline of <15B for every <.01 in Unemployment Rate. This metric may be convenient but also rigid as markets will elasticize the data if trending in that direction. Conversely, increasing by 15B for any .01 uptick was not held out as an alternative as participation distortion emerges. The Fed model suggests the FF rate is -5 and heavily accommodating. Our model says the FF rate-in equilibrium (policy neutral) would be 16bps, almost spot on.

We feel the tapering balloon is as much a response to other CBs acting more aggressively as faith in the expansion. When QE-Infinity (a terrible moniker) was announced most other DM CBs were stalled, thus helping the Fed tilt toward more. The tapering movement has gained traction as other CBs have taken the clue and re-energized their playbooks. We expect the Taper idea to continue to float around and even cause "exit" fears to percolate. "Fed insolvency" and Treasury remittance stats are already common. The note market is nearly unchanged from the beginning of the year. If, as many argue, term structures are significantly distorted by Fed actions, the push-back has yet to emerge.